Why Midcap Mutual Funds may struggle to beat this New Index from NSE!

The NSE has launched a new strategic index, the NIFTY Midcap150 Quality 50 Index. We find out how well active midcap mutual funds have fared against this index

Published: November 2, 2019 at 12:58 pm

The NSE has launched a new strategic index: NIFTY Midcap150 Quality 50 Index. This has 50 stocks with higher profitability, lower leverage and more stable earnings from the Nifty Midcap 150 universe. We find out how this index has fared against the parent index, Nifty Midcap 150 and active midcap funds.

This is yet another strategic or smart-beta or factor-based index, combining passive investing with active stock selection. Regular readers may be aware that we have discussed different types of these indices before:(1)  How good are the top 10 stocks of NIFTY Quality Low-Volatility 30 Index? (2) Are Nifty Smart Beta (strategic) Indices better than the Nifty Next 50? (3) Watch my talk on momentum and low volatility stock investing in India

Construction of the NIFTY Midcap150 Quality 50 Index

According to the methodology document, equal weight is given to return on equity (last fiscal year), debt to equity (last fiscal year) and last five year EPS growth variability. The debt to equity factor is not used for financial services stocks.

A quality score is defined as 0.33 * Z score of ROE + 0.33 * – (Z score of D/E) + 0.33* – (Z score of EPS growth variability). Here Z scores refer to how much a particular factor deviates from average value divided by the standard deviation.

The index is weighted by the square root of the free float market cap times the quality score. Each stock can either have a maximum exposure of 5% or five times its weight in the parent index.


Midcap150 Quality 50 Index vs Nifty Midcap 150 Index

The quality index has comfortably beat the parent index since inception. However, a rolling returns analysis will reveal consistency in outperformance.

Midcap150 Quality 50 Index vs Nifty Midcap 150 Index Since inception price comparison

The new index has a short history but it has done well over every possible three year periods.

Midcap150 Quality 50 Index vs Nifty Midcap 150 Index Rolling retuns comparisonThe risk of the quality index is consistently lower than the parent index.

Midcap150 Quality 50 Index vs Nifty Midcap 150 Index Rolling Risk or standard deviation comparison

Active Midcap Funds vs NIFTY Midcap150 Quality 50 Index

We consider every possible 5,4,3,2 and one year period in a funds history from April 2006.

Five years: Out of the 23 funds in the midcap category, 19 had at least a five-year history. Only two funds were able to beat this index more than 60% of all available five-year returns. That is, if we consider 100 five year return durations (from rolling returns), two funds beat this index more than 60 of those instances. We shall call this rolling returns consistency.

Four years:  Same as above. Only the same two funds managed 60% outperformance.

Three years: Only 1/20 funds managed a 60% plus outperformance.

Two years:  Only 1/22

One year:  2/23

Summary

This is terrible underperformance! The only reason to pick active midcap funds is that there no proven, liquid alternatives. The Motilal Oswal Nifty Midcap 150 Index Fund is too young to judge. The Midcap ETFs (for instance from ICIC) have too low an AUM and will have to be tested during turbulent times. We shall have to keep an eye on this quality midcap index.

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